Costs of the living wage

The living wage could put some people out of work even if it has only small effects upon aggregate employment.

I say so because of a new paper by Jan Kabatek which studies the effect of the Dutch minimum wage, which increases with age for workers up to the age of 23. Mr Kabatek shows that workers are more likely to lose their jobs around the time of their birthdays*. This is consistent with employers getting rid of workers as they become more expensive, and replacing them with cheaper younger ones.

This might have implications for the living wage. It will apply only to over-25s. Mr Kabatek’s work suggests that it might reduce employment among those slightly over 25 at the expense of younger workers.

Supporters of minimum wages sometimes claim that the price-elasticity of demand for labour is low because employers cannot easily substitute between capital and labour. That’s true. But they can more easily substitute between 25-year-olds and 24-year-olds. Granted, such substitution might be small – as it is in Mr Kabatek's study – but the more the living wage rises relative to under-25s wages the bigger this effect might be.

Does this matter? Maybe not. On the one hand, youngsters suffer disadvantages in the labour market: the unemployment rate for 18-24 year-olds is 12.3% compared to just 4.9% for 25-34 year-olds. Anything that tilts the balance in their favour is therefore a good thing.

But on the other hand, over-25s are more likely to have families so their joblessness might add to child poverty. And whereas youngsters’ low wages might be due merely to inexperience, over-25s low wages might be due to more fundamental reasons for low employability such as low skills or poor health. This means they could find it especially hard to get back into work.

For me, there are two points here. One is that the effects of minimum wages aren’t all obvious from macro data: substitution from 25-year-olds to 24-year olds won’t show up in the headline monthly labour market data. There’s danger therefore that (wilfully) incurious journalists and politicians will under-estimate the consequences of the living wage.

Secondly, all this corroborates my priors – that the living wage is a poor way to help the low-paid. Better options would include stronger trades unions, increased aggregate demand and hence a tighter labour market, and a job guarantee. All these policies would increase their bargaining power.

But let’s face it, Osborne did not announce the living wage because it is the best way to help the low-paid. He did it to embarrass the Labour party and to try to reduce in-work benefits.  Such motives are no way to improve the life-chances of the worst-off.

* The word “around” does some work here. Some workers are sacked just before their birthdays, in anticipation of their higher cost. Mr Kabatek says that research which ignores this possibility – such as this paper – understates the cost of minimum wage laws.

Comments

[Luis Enrique]

v interesting. although not clear to me why union wage bargaining does not price some out of work whilst min wages do.

on the capital substitution point, see the putty clay paper here:
https://sites.google.com/site/isaacsorkin/papers
about the min wage and restaurants. here established restaurants cannot substitute between workers and capital at all, and the effect of min wage happens via capital intensity of new restaurants

[chris]

Ta Luis. The case for unions is that they can take account of local/business circumstances where higher wages might price people out of work, to a greater extent than can a national one-size-fits-all living wage - especially if that wage is set by grandstanding politicians rather than on the basis of research.

[Luis Enrique]

chris - gotcha, thanks. Obvious now you say it. I suppose the famous German union brokered wage restraint a case in point too.

[aragon]

Why should raising the minimum wage, lead to a greater difference in the relative pay of people under twenty three/five and over, in fact you could reduce difference if you wish to reduce the identified effect. The effect is small and may be desirable, and can be adjusted as a matter of policy.

This seems to be a case of economists chasing ever decreasing delta. Unions are more likely to create special cases, dependent on industry sector, and don't see this as more desirable than a minimum standard.

The minimum wage is an excellent way of helping the low paid. Better than Unions, as it applies across all sectors, and employers, complimentary with a job guarantee, which just absorbs the supply of labour and of ensuring aggregate demand exists at the minimum wage.

And much better than other government economic policies which distribute wealth with more undesirable side effects and less moral justification. e.g. Quantitative Easing.

If you wish to provide employment do so (Job Guarantee) do not reduce the cost of Labour below a reasonable standard of living or subsidise it (Tax Credits).

We have a long way to go, to achieve the type of society of my imagination.

[aragon]

You praised Howard's paper (perhaps I should read it).

http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2013/11/living-wage-macroeconomics.html

An expansionary macro-economic policy is a given as far as I am concerned, but a minimum wage combined with job guarantee (which offsets the fiscal tightening), ensure the income of the lowest paid at a higher level than in the absence of a minimum wage.

Demand is guaranteed, and minimum pay ensured, some wage inflation should result, as should an increase in economic activity.

If you are unemployed you can avail yourself of the job guarantee and therefore the minimum wage.

People still on benefit could be addressed through a basic income.

NB: The living wage includes benefits, so may need to be revised upwards as benefits are withdrawn.

[Oldcobbler]

The self-employed seem to be largely ignored in these debates about minimum / living wages......

[Bob]

Good post Chris.

[aragon]

The law applies to the Self-employed, pay yourself the minimum wage from income, or capital, or you will be breaking the law.

The self-employed will have access to the basic income and the job guarantee.

You could work, and just receive the basic income if you are starting a business, and have insufficient capital and are a sole trader etc.

Self-employed hairdressers or zero hours contracts (disguised employment - IR35), would be regarded as employed and the employer held responsible for their income.

[jon]

V interesting. But the strong 'motives' claim in the last para seems to me false. I don't see why good results require pure motives, nor why pure motives guarantee better results.

I also wondered if measures to massively reduce the cost (to taxpayers & dwellers) of housing (such as the mass production of prefabs) could benefit the poor more than increasing their wages. After all what makes wages low isn't their absolute level but their level relative to costs. I wonder what would be the effects of such a measure.

[jon]

...or a long-run reduction in housing costs through a comprehensive 50-year plan.

[Dinero]

Also a mandated minimum wage with no opt out allowed by the employee results in there being no low productivity low stress jobs available for workers who would care to choose them if they were available.
It seems that unemployment and low wages pull the policy maker in two opposing directions at the same time. Having a lowest wage mandated by law for the low pay issue exacerbates the unemployment issue.

[richclayton3]

I think you may be succumbing to confirmation bias: the paper you link to in the starred note at the bottom of the post, and which you say Kabatek asserts fails to acknowledge the possibility that employers lay off workers before their birthday (for the year in which the min wage would increase), does in fact test exactly this (looking back a full year before the relevant birthday as well as a full year after) and finds not disemployment effect.